How to Read My Stock Analysis Reports

In this article, I will explain, step-by-step, how to interpret one of my stock analysis reports. This website is intended to be helpful for both new investors and experienced investors who are looking for good summaries of investment ideas. This article attempts to bridge the gap, so that people who may not be too familiar with stocks can follow along with my stock analysis reports.

Below is my dissected 2010 Johnson and Johnson Dividend Stock Analysis Report. I will dissect it with commentary so that you can follow along with the example. It might be a good idea to click on that link and give a quick glance at the original report before you read this dissected commentary.

The text in the blockquotes comes from my JNJ analysis, while the regular text that comes after each blockquote is my commentary/dissection of that article to explain what each part means.

Summary

-JNJ is a classic blue chip company that has raised dividends for 47 straight years and is currently trading at a historically lower than average valuation.
-Revenue Growth: 5.5%
-Earnings Growth: 7.5%
-Cash Flow Growth: 8.2%
-Dividend Growth: 12%
-JNJ currently yields 3.1% with a modest payout ratio and is also averaging a net $5 billion in share repurchases per year.
-For a company of this size, the balance sheet is remarkably conservative.
-Overall, with the low valuation, stability, international exposure, and solid product portfolio, I think JNJ shares are undervalued currently. This would be a good reasonably conservative dividend stock pick for a dividend growth portfolio.

I try to put some of the most useful information at the top, so that people can quickly be on the same page as me as to why I view the company as a reasonable potential investment. I say what the company does, what their growth and dividend history looks like, whether they have a lot of debt or not, and an overall opinion of whether I think this is a good investment or not, and what price I’d be willing to pay for shares of the company at the moment.

As a quick note, the company is called Johnson and Johnson, and “JNJ” is the ticker symbol. This is the official symbol of the company on the stock exchange that it trades on. During the course of the analysis, I often use the ticker symbol in place of the company name.

Overview

Johnson and Johnson is a diverse global healthcare company with approximately half of their revenue coming from outside the United States. Founded in 1886, the company has paid increasing dividends for 47 consecutive years and is therefore firmly among the dividend aristocrats. JNJ is further broken down into three main business segments:

Consumer Segment Johnson and Johnson’s Consumer Segment sells a variety of strong name brand products including Listerine, Dabao (China), Neutrogena, Band-Aid, Tylenol, Carefree, Splenda, and of course Johnson’s Baby Care. This is JNJ’s fastest growing segment.

Total Segment Revenue: $16 billion

Aspect Revenue
Over the Counter $5.9 billion
Skin Care $3.4 billion
Baby Care $2.2 billion
Women’s Health $1.9 billion
Oral Care $1.6 billion
Wound Care/Other $1.0 billion

Pharmaceutical Segment

JNJ’s Pharmaceutical segment is the seventh largest pharmaceuticals company in the world. This is JNJ’s largest but slowest-growing segment.

Total Segment Revenue: $24.6 billion
Their product portfolio is widely diversified, with no product making up more than 15% of sales.

Medical Devices and Diagnostics Segment

JNJ’s device and diagnostic segment has experienced 6.4% growth, and currently houses the world’s number 1 prescription contacts, Acuvue, as well as diabetes care, endo-surgery products, and more.

Total Segment Revenue: $23.1 billion

In the overview section, I delve into some of the history of the company and explain what their products are. How much I write here usually depends on how complex the company is. Johnson and Johnson is a very large, diverse company, so I considered it important to show what their company structure looks like and how diversified their product range is.

Revenue, Earnings, and Cash Flow

Johnson and Johnson has seen steady growth for the last several decades. The economic crisis in 2008 and 2009 has slowed growth, but cash flow remains strong in 2009.

Revenue Growth

Year Revenue
2009 $61.897 billion
2008 $63.747 billion
2007 $61.095 billion
2006 $53.324 billion
2005 $50.514 billion
2004 $47.348 billion

Annualized, JNJ has had a 5-year revenue growth rate of 5.5%. Revenue growth from 2004 to 2008 was nearly 8%, but 2009 represented a rare decrease in revenue for JNJ.

Revenue is basically how much the company makes in sales each year. It is the total amount of money a company makes in a year, before costs, taxes, and depreciation are considered. Revenue is an important metric because growing revenue shows that the company is either selling more products and services, or they are effectively increasing the price on their products and services, meaning that there is more demand for their products and services. If revenue is declining while earnings are increasing, then you can expect that eventually earnings will run into a wall and stagnate, since optimization can only reach a certain extent. Eventually, a company will be as efficient as possible, so if they aren’t really expanding their business, then earnings growth will suffer.

If you haven’t read my article on the raw power of compounding, I suggest you give it a read. Annualized growth is a description of how much the company grows each year. I look at the annual growth of revenue, earnings, cash flow, and dividends.

So for example, if I make $1,000 in revenue this year, and $1,120 in revenue next year, then my revenue has grown by 12% in that year. If I make $1,254 the year after that, I have grown revenue by 12% again. Notice that the revenue growth during the second period was $134 while the revenue growth during the first period was only $120. This is because annualized growth compounds, meaning that it grows exponentially. Each 12% of growth is based off of the previous year, which was larger than the year before that.

In this stock analysis, JNJ has had 5.5% annual growth. It doesn’t mean that each year’s growth was exactly 5.5% larger than the year before it, but over the course of 5 years, that’s what the average has been. Revenue growth of 5.5% means that the company’s revenue will double every 13 years.

Earnings Growth

Year Net Earnings
2009 $12.266 billion
2008 $12.949 billion
2007 $10.576 billion
2006 $11.053 billion
2005 $10.411 billion
2004 $8.509 billion

Annualized, JNJ has had a 5-year earnings growth rate of 7.5%. From 2004 to 2008, the year of the economic crisis, the growth rate was 11%.

Annual earnings describe how much money the company actually made in net profit that year. They receive their revenue, but then they have paid employees, paid for materials, paid interest, paid taxes, and so forth. Also, if the company has manufacturing sites and such, then those things depreciate over the years, just like cars do. As these materials depreciate, they are accounted for in earnings, even though the company isn’t actually “paying” money to depreciation.

Earnings are important, since a company could be selling all sorts of goods and services for a ton of revenue, but their costs could be high, meaning they don’t have much earnings. As investors, we are owners of this company, and we want to see profit. This is among the most important of pieces of information in the report.

All things being equal, if the valuation of the company is reasonable today, then earnings growth gives you a decent estimate for how much the price of the stock would reasonably increase per year. Of course, there are plenty of other factors involved, like the market over or under-valuing the stock next year, or changed debt levels, or overall outlook for the company. I attempt to invest in companies that I consider to be undervalued today, so that over the following years, the stock price is likely to increase faster than earnings as it becomes more highly valued.

Cash Flow Growth

Year Cash Flow from Operations
2009 $16.571 billion
2008 $14.972 billion
2007 $15.249 billion
2006 $14.248 billion
2005 $11.877 billion
2004 $11.131 billion

Cash flow is looking brighter. Revenue and Earnings dipped down in 2009, whereas Cash flow dipped in 2008 and recovered in 2009 with a record-breaking year in terms of cash flow. Annualized over 5 years, cash flow growth for JNJ has been 8.2%.

Cash flow is confusing to some people, but it’s actually more straightforward than earnings are. Cash flow shows how much money flowed into and out of a business. To determine cash flow, you start with the earnings, but then strip away all of the stuff that didn’t actually affect cash. For example, if a company’s manufacturing site depreciated in value due to time, this loss is reflected in the earnings, but not the cash flow, since no cash is actually being paid out. Similarly, a company often has an inventory of its products. If they keep making products but don’t sell them, then their inventory increases and the price of these goods are reflected in the earnings statement even though they didn’t actually sell them. This is misleading, because we actually want the company to sell products and make money! Cash flow shows things like this. It strips away increasing inventories and similar things that can be misleading. Another thing cash flow strips away is receivables. Companies don’t pay other companies right away, and sometimes they can fail to pay for things, just like how some people fail to pay their credit card bill. Money that is owed to the company is shown by the earnings report, but cash flow only takes into account money that the company has actually managed to pull in. Ultimately it’s all about the cash.

Margins

Operating margin for JNJ is currently 25.8% and Net Profit Margin is currently 19.7%. This is one of JNJ’s strongest areas.

The Operating Margin is a percentage that shows how much money the company has made after costs they have paid out, except for interest and taxes. Net Profit Margin is how much the company made, after all expenses including taxes and the like, compared to the revenue.

As a simplified example, if I own a gym that makes $200,000 in revenue each year, but pay out $160,000 to employees, maintenance, advertising, and taxes, and am able to pocket $40,000, then my profit margin is $40,000 divided by the total revenue of $200,000, which comes out to 20%. In other words, my net profit margin is 20%. The $40,000 is more like cash flow, but as a simplified example to define profit margin, it can be understood to be earnings.

Margins are important because they show how efficient a business is. It’s important to note, however, that different industries have different margins. Software companies, for example, typically have very high profit margins, since they have low equipment and commodity costs. Packaged snack food companies tend to have lower profit margins since they have to buy a lot of raw materials and have to keep prices as low as possible. So when evaluating a company’s margins, it makes sense to evaluate them compared to their peers and competitors in their own industry.

Margins show how competitive a company is, how much demand they can expect for their products, and how they are defended against fluctuations in cost of raw goods. Higher margins imply more pricing power.

Dividends and Share Repurchases

Johnson and Johnson has been a solid dividend payer for decades. With a current dividend yield of 3.09%, JNJ presents one of the highest yields it has had in years. In addition, JNJ has been actively repurchasing shares for years now, averaging about $5 billion in net share repurchases per year.

Dividend Growth

Year Dividend Yield
2009 $1.93 3.26%
2008 $1.795 2.88%
2007 $1.62 2.75%
2006 $1.455 2.43%
2005 $1.275 2.03%
2004 $1.095 2.03%

From 2004 to 2009, that’s an annualized dividend growth rate of 12%.

Payout ratio is only 44%, so dividends are safe and have plenty of room to grow.

If you aren’t familiar with dividends, read my article that explains dividends.

I want my dividends to grow over time. Using the example above, if I bought 1000 shares of Johnson and Johnson in 2004, then each share would pay me $1.095 that year, and I would make $1095 annually in passive income from this investment. Johnson and Johnson, however, increases the dividend each year, almost like clockwork. So in 2005, I’d have made $1.275 per share, or $1275 in annual passive income. By the time 2009 rolls around, I’m making $1.93 per share, or $1930 per year in passive income. This is getting close to double the passive income from 2004! If I had reinvested my dividends each time, meaning that I take my dividend payout and purchase more shares each time I receive a dividend, then my dividend passive income will increase even faster, because I not only make more money per share each year, but also have more shares than the previous year.

As can be readily seen, dividend growth is powerful. If, say, Johnson and Johnson managed to grow dividends by 12% per year going forward, which would be quite spectacular, then my $1095 annual passive income in 2004 would turn into $10,562 per year 20 years later in 2024! If I reinvested dividends that whole time, it’ll be even higher than that.

The payout ratio is a measure of how much of the per-share earnings a company is paying out in dividends. A payout ratio of 100% means that every dollar of earnings is being paid out in dividends. A payout ratio of 0% means that the company is not paying any dividends at all. At this time, Johnson and Johnson is paying out 44% of its earnings as dividends, and using the other 56% to reinvest in growing their business. We want a payout ratio to be kind of low, since a company might have a bad year in terms of earnings, but still increase dividends, by paying a larger amount of earnings as dividends. In 2009, Johnson and Johnson had lower earnings than in 2008, yet still paid more in dividends, since their payout ratio was comfortably low.

The dividend yield is a measure of dividends-per-share divided by the price of the share at the time. So if a company’s shares each cost $50 at the moment, and each share pays $2 this year in dividends, then the dividend yield is 4%. A higher dividend is usually good, as long as the payout ratio is low enough.

Share repurchases are another way that a company can return money to shareholders. Basically, a company can purchase its own shares and eliminate them, which decreases the total number of shares available, and that means that the company profits are divided among a smaller number of shares, so the value of each share should theoretically increase. The advantage of share repurchases over dividends is that they are not double-taxed like dividends are. The disadvantages are that they can’t be used as income and the company may not make smart decisions when repurchasing shares (like repurchasing them at a high price).

Balance Sheet

JNJ is the pinnacle of stability. Their operations are diverse, and their balance sheet is superb. Current ratio is a healthy 1.8, and LT debt to equity is a very modest 0.16. JNJ is more conservative than its peers in terms of leverage.

LT debt is long term debt. Debt isn’t a bad thing for a company, since they can often get higher rates of return from things they use that debt for than they pay in interest on that debt. It’s like me taking out a loan with a 5% interest rate, but then using that money to build a business and get 15% back each year. Even companies like Johnson and Johnson and Coca Cola, that are over 100 years old, often have debt because it helps them accelerate their growth.

I don’t want to see too much debt, though. That’s a sign of trouble. We want the LT debt to equity to be as low as possible, since that means more stability, more growth opportunities, and money is not being thrown away on interest payments on that debt.

Current ratio is “current assets” divided by “current liabilities”. This should be pretty high, and hopefully higher than 1, meaning that it has enough assets to pay its short-term debts and obligations. A current asset is something like cash or a receivable, not a manufacturing facility (that would be a long term asset).

Investing Thesis

In 2007, JNJ opened the Emerging Market Innovation Center, a nearly 100,000 square ft facility, in Shanghai to better address the concerns and needs of the world’s developing countries. In 2008, JNJ acquired Beijing Dabao Cosmetics company, and with it China’s number 1 brand of skin moisturizer. The company takes in half of their revenues from abroad, and is aggressively seeking out partnerships and top product lines throughout emerging countries. Although JNJ is a solid blue chip with $63 billion in revenue, they certainly have ample room to grow.

Based on strictly the earnings growth and dividend yield, JNJ is a reasonable pick. With JNJ, you get 7.5% five-year earnings growth and a 3.09% yield, which likely will fetch a 10% annual return or so, which seems pretty good right now. Analysts predict a 6.2% EPS increase in 2010 and an 8.7% increase in 2011. If that was all, JNJ would be a pretty good pick, but in addition, JNJ is at a low valuation right now compared to both the broad market and its own historic valuation. I think it’s inevitable that JNJ will eventually arise to a higher multiple as the economy recovers and healthcare politics are less uncertain.

This is my qualitative section where I explain why I think this company will continue doing well. Numbers are important, but the past history of a company is no guarantee of future performance. If it were, then supercomputers would be the richest among us, since all they need is data.

Does the company have a competitive advantage over similar companies? Will there be continued and increasing demand for its products? Is it expanding globally? What macro-economic factors will help or harm this business in the future? These are all things that should be considered.

Risks

Although JNJ is a very safe company in general, they do face profitability risks. Ongoing healthcare reform could potentially reduce their profit margins in the US. This is buffered by their international growth, which remains strong. As shown by the company’s lackluster performance in 2008 and 2009, JNJ like most other large US companies is dependent on the financial improvement of the United States.

Every company has risks, some more than others. A high-tech start-up company that is dependent on the success of a single, unproven product is obviously more risky than a 100-year-old business that sells baby lotion, mouthwash, and Tylenol, but there is still risk in JNJ. The future always has a degree of uncertainty, and every business faces challenges that they have to try to overcome. It’s important to have an idea on what kind of risks your investments have. I’m more willing to take on risk if it offers a high upside, so all things must be considered.

Conclusion and Valuation

Overall, I think JNJ is a solid pick for dividend growth right now. It’s a stable, incredibly diverse, growing company with a large international exposure, an above average dividend yield, and room to continue. In my opinion, it’s a good value as long as it remains below $69, which would give it an earnings multiple of 15.

This is where I sum up my thoughts, reiterate the growth, and give a price target. Great companies don’t necessarily make great stocks, since people might be paying too much for the stocks. The price to earnings ratio (P/E) or “earnings multiple” is just the stock price of a share divided by the earnings per share of that company. So if company XYZ has a share price of $50, and makes $5 in earnings-per-share, then the P/E or “earnings multiple” is 10. I want a low P/E, because I want to buy into companies that are undervalued, meaning that the price is low compared to how much I think the share is worth. If you go to a store, and see two equal products, but one is 20% off, you’ll of course want to get the cheaper one.

Full Disclosure: Long JNJ
You can see my full list of individual holdings here.

I make sure I disclose any personal positions about the companies I am discussing.

If you want more information on the various stock metrics, consider reading:
Important Stock Metrics for Dividend Growth Investors

If you’d like to see my latest stock reports:
Read My Latest Dividend Stock Analysis Reports

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Comments

  1. Keep posting stuff like this i really like it

  2. Thanks, I’m glad it’s helpful to you.

  3. Wow, this is thorough!

    By the way, welcome to the Yakezie. I’ll make sure to check out your blog more often b/c I’m trying to teach myself more about the market this year.

    Thanks!
    Austin @ Foreigner’s Finances

  4. Thanks Austin.

    I like your post about Japanese personal finance gripes.

  5. All you stock analysis reports are amazing and I believe that all of them are accurate results.

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